Self-employment

Pay Yourself Right When Being Your Own Boss

The dream of working independently is a reality for almost 10 million people in the United States, or roughly 10 percent of the workforce, according to the Bureau of Labor Statistics. The rewards of self-employment include independence from supervision, the ability to set your own hours, and the satisfaction of knowing you are writing your own ticket. And yes, if you want, you can often work in your bathrobe.

Technology makes it easy to work wherever you go. With an up-front investment of a few thousand dollars in a computer, bandwidth (telephone, fax, Internet), and possibly a wireless device, many people who work with information are in a position to strike out on their own.

However, despite the freedom and opportunity, self-employed people, like all businesspeople, still must answer to a customer or a client. Moreover, self-employed people bear all of the responsibilities for their success, including doing all the work that can't be billed to a client or charged to a customer. To get paid, you have to do it all.

Training -trends in the industry, conferences, new skills to keep pace with the market.

There are several ways to work independently, including some that shift these responsibilities to others. If you work on a temporary basis, possibly as an employee of an agency, you can avoid some of the expenses and responsibilities of self-employment yet retain some of the independence. If you work as an independent contractor, you will receive a 1099 from the client and may earn slightly more than if the work came through an agency, because you will find the work yourself. And if you work as a sole proprietor, your work will be considered a business service, for which you will be able to charge fees comparable to those of other professional services firms. Some self-employed people combine these types of relationships, which complicates taxes but can help manage financial risk.

Set fees that make you competitive, yet profitableWhen you are self-employed, you are responsible for your own compensation and benefits. The good news is, you get to decide how much to charge for your work. The reality is, there is a market rate for professionals of every kind. Unless you're a household name within your industry, or outstandingly well qualified and a great salesperson, you will have to charge somewhere near market for your services.

Temp agency fees. If you work for a temporary agency, you will be paid a rate set by the agency. There may be some room to negotiate; for example, you may be able to refuse assignments that pay less than your desired minimum. Temporary agencies charge their clients fees that allow them to pay their workers a competitive market rate, plus a margin for business expenses and profit.

Independent contractor fees. If you work as an independent contractor without going through an agency, you have some leeway in establishing your professional fees, but you should charge close to market. To calculate this rate, start with the prevailing full-time salary for that job. Then divide by 2080, the number of work hours in a year (2080 = 52 X 40). This is the hourly rate for your job if benefits are being paid for by the employer.

But as a contractor, you need to pay for your own benefits, as well as additional Social Security contributions, so the number needs to be higher. Salary.com uses an adjustment factor of 30 percent to convert an hourly wage for a salaried employee to an hourly wage for a contract employee. Multiply your unadjusted hourly rate by (1 + 0.3) to get your adjusted hourly rate. For example, if your unadjusted hourly rate comes out to $20 per hour, your contract rate should be $20 * (1.3) = $26.

Sole proprietor. An agency might pay a contract Web designer $45.20 per hour, but charge the client considerably more - well over $100 - to cover business expenses and make a profit. When you're self-employed, you assume both the responsibilities and the rewards of being an agency. If an agency charges $125 per hour and you want to do the same, you should be able to offer your clients a comparable level of service. You might have to work 50 hours a week to do 20 or 30 hours of work you can bill to a client. Shorter projects tend to be less profitable than longer ones, because it still takes just as long to find them. When setting fees as a sole proprietor, research the prevailing rates in your industry as well as your reasonable costs of doing business.

Sometimes, as a sole proprietor, you can work on retainer, for a guaranteed minimum number of hours or days. In exchange for the reduced administrative responsibilities, you can lower your rate somewhat. The risk of working on retainer is that you will become too dependent on one source of income. If you lose the client, it could take a while to find other revenue. For a sole practitioner, networking for new customers is critical and it is more effective if you have more clients to pass on the favorable recommendations for your good work. Working on retainer can also create problematic tax consequences if the relationship begins to resemble part-time work or independent contracting. Ask your accountant for advice about working on retainer.

Pay yourself generous benefits, as any good employer would doMany self-employed people make the mistake of paying themselves less than they deserve by underpaying in benefits. One of the goals of self-employment should be to earn an amount comparable to what you would earn if you worked for someone else. You could keep all the fees you earn in cash, but then you wouldn't have some important protections and benefits.

Sick leave, holidays, and vacation time. Paid time off is a price of freedom. When you don't work, you don't get paid. You can build paid time off into your professional fees if the market will allow. Instead of dividing by 2,080, divide by another amount - 2,000 (two weeks of paid time off), 1,960 (three weeks), or 1,920 (four weeks), for example.

Healthcare. Medical insurance can be very expensive, especially if you are accustomed to getting it for little or nothing each month. Employers typically pay at least two-thirds of the cost of medical insurance. On your own, you not only must buy your own insurance, but you must also pay individual rates that are much higher than the group rates most employers receive. Obtaining insurance for yourself and your family will be more complicated if you or one of your family members has a preexisting medical condition.

Even if you work for yourself, you may still be able to purchase medical insurance at group rates through a professional association. Or, if you have an employed spouse who can extend this benefit to you, you can focus on bringing in cash. Having two medical benefit policies is expensive and unnecessarily redundant; cash is never redundant.

Retirement plans. There are many options: a simple IRA, a Simplified Employee Pension Plan (SEPP), a simple 401(k), a profit-sharing plan, a Money Purchase Plan. A common approach for self-employed people is to use a combination of a profit-sharing and money purchase plans that allows you to contribute 20 percent of your earnings, up to $30,000, toward your retirement each year. The combination plan does not lock you into making the mandatory contributions. This is a useful feature as business conditions can fluctuate and personal circumstances can change.

Life and long-term disability insurance. Life insurance is very important if you have a mortgage and children. These responsibilities need to be met even in death, so you need to estimate the cost of your remaining obligations and buy insurance to cover it. For most people, term insurance is enough. Whole life typically makes sense only if you have a large estate. Term is cheap and you can purchase considerable protection for your family. Another advantage to term insurance is that you can terminate it or scale it down when your house is paid for and your children grown and on their own. At that point most of the rationale for having insurance is gone.

Long term disability insurance is extremely important. If you become unable to work, regardless of the reason, the combination of your living expenses and your lack of income can bring extreme financial hardship to your family. Disability insurance provides replacement income in the event that you can no longer work. Buy it-it's cheap.

Social Security and Medicare. These are not benefits, but taxes. When you work for a company, the employer pays half the Social Security (FICA and FUTA) deduction; the other half is taken out of your paycheck. When you become self-employed, you are both employer and employee, so you pay the full Social Security taxes, double what you pay as an employee.

Office expenses are a cost of doing businessIn addition to benefits, you will need to purchase office equipment, office supplies, computer hardware and software (and upgrades), and other essential items. You may also need to hire other people as vendors to do some of the work. These expenses, though tax-deductible, can add up. In addition to office furniture and supplies, a Web designer III in Kansas City needs, at minimum, a state-of-the-art computer, laser printer, scanner, high-speed Internet connection, telephone, fax machine, and thousands of dollars' worth of software, all of which must be kept current. The designer probably also needs a good accountant. These expenses should be factored into a sole proprietor's professional fees.

Expenses associated with a project can be billed directly to the client. For the Web designer in Kansas City, these include typefaces, photography, illustration, third-party images, high-resolution scans, presentation materials, long-distance telephone charges, and other costs associated with getting the work done.

Temporary workers and independent contractors are usually able to work in the client's office using the client's equipment, administrative resources, etc. If you work as a temp or a contractor and the client expects you to provide your own computer or other services, you should raise your rates accordingly.

Cash may not always come in when you expect itIn addition to deciding how much you should get paid, you also need to determine when you will get paid. If you wait until the end of a job to submit an invoice, you may need to wait another 30 days - or longer, if the client is slow to pay - before you see any money. This lag between when you get the job and when you get paid can be difficult to manage, especially if you incur expenses during the project. When an employee starts a full-time job, it typically takes two weeks to a month until the first paycheck. But when you work for yourself, it can take much longer.

One way around this cashflow problem is to charge a certain percentage of your fee up front, a certain percentage when you reach a major milestone, and the balance when the project is over. You can establish these terms in your original proposal so that the client is not surprised later. In addition, self-employed people commonly add language to their invoices to the effect of "Terms: net 30 days" to show they expect to be paid promptly. Many clients pay on time, some within 10 days of the date of the invoice. Find out the typical arrangements in your field, and discuss payment terms with each new client.

Occasionally a client will just not pay at all. It may happen once every several years, usually because the client is having problems with its business. Although the client is contractually obligated to pay, it may be unable to pay, or it may refuse for another reason. Sometimes you can renegotiate with a client to make partial payments over an extended period. A collection agency or a lawsuit is a last resort: the effort may or may not be successful, it will cost you more money before you get paid, and by then the business relationship is likely to be destroyed. Most business owners understand that they may not be able to collect 100 percent of their fees, so as long as bad accounts represent only a small fraction of total revenue, they are seen as a cost of doing business. Businesses fail, but failed entrepreneurs usually begin again.